Breakingviews - Xi enters Shanghai in high-stakes tech IPO race

A man talks on the phone inside the Shanghai Stock Exchange building at the Pudong financial district in Shanghai November 17, 2014. International buyers snapped up Chinese stocks on Monday at the debut of an exchange link that allows Hong Kong and Shanghai investors to trade shares on each other's bourses, a major step towards opening China's tightly controlled capital markets. The so-called Stock Connect scheme gives foreign and Chinese retail investors unprecedented access to the two exchanges, which some analysts said could eventually lead to the creation of the world's third largest stock exchange. REUTERS/Carlos Barria (CHINA - Tags: BUSINESS) -

HONG KONG (Reuters Breakingviews) - President Xi Jinping has entered Shanghai in the high-stakes race for technology stocks. China’s leader granted the city a so-called “science and innovation” board. It also will test a looser U.S.-style system for new listings – an overdue reform. Yet officials may rue the volatility it’s apt to bring.

The Shanghai Stock Exchange, with a market capitalisation of over $4 trillion, aimed to become an international venue equivalent to New York’s Nasdaq by 2020, but that goal has been quietly abandoned. It struggles to compete with the Shenzhen bourse, which attracts startups to its ChiNext market. Hong Kong, too, increasingly woos the likes of Xiaomi. Shanghai, meanwhile, is overweight state-owned dinosaurs. After years of lobbying Beijing for help attracting tech outfits, it finally got its wish.

A long-promised registration-based listing system is included, to replace the tedious process of applying to the China Securities Regulatory Commission for permission to sell shares. Authorities closely manage the pace and pricing of initial public offerings, resulting in a backlog of hundreds of companies. When indexes correct, the CSRC also tends to freeze approvals because mom-and-pop investors tend to think new issues suck money away from existing stocks.

The system warps China’s primary market. Price guidance, at 23 times earnings, has resulted in huge first-day trading pops, with shares almost always rising the maximum 44 percent. That, plus scarcity, makes IPOs one-way bets on double-digit returns. The difficulty of listing makes tickers themselves valuable, so shares in dual-listed companies such as Bank of China cost an average 20 percent more on the mainland than Hong Kong.

Letting companies decide when to list and for how much would eliminate such distortions, but not painlessly. Companies most likely to list on the new Shanghai board will be small and private: not prone to best-in-class corporate governance. The history of new markets in China suggests there is a high chance for shareholder abuse in early phases. Indexes could suffer if retail buyers react by selling.

The biggest risk, however, is that short-term pain causes officials to cave and reverse this long-overdue liberalisation, as they have done before. For now, that makes the Shanghai board itself less a “buy” than a “hold”.

Breakingviews

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